Bank stocks could be a good bet with rates low

February 12, 2008

Q: I'd like to invest in bank stocks now that short-term interest rates have been slashed. Is this a good idea, and how do I go about doing this?

A: We could debate whether the government should give do-overs to overly aggressive borrowers, banks and speculators in the overheated housing market who knew the risks but took them anyway. But that's a topic for someone else.

The fact is, the government has chosen to help these people out, and you might as well try to profit from it. The biggest beneficiaries will be banks and investment banks who bought and owned packages of shaky loans. The reduction in short-term interest rates may make the loans more valuable, which will boost these banks' portfolio values. But the lower rates also give the banks a big boost in their core business of making loans, since their cost of money will fall.

Bank stocks have been quintessential value-priced stocks, and as a group, these have done rather well. You could consider buying an individual bank stock. You might look at the ones that have fallen most, and that you think have a strong chance of coming back. That will require a great deal of research.

You might also consider buying an exchange-traded fund, or ETF, that owns a basket of bank stocks. That way you get exposure to the industry but you avoid the risk that one particular bank doesn't recover well.

With that said, you might actually be better served by buying an ETF that owns all kinds of large value-priced stocks. An ETF like this would give you a nice helping of bank stocks. A few examples: Vanguard Value ETF vtv, iShares Russell 1000 Value iwd and iShares Morningstar Large Value index fund jkf.

Consider the Vanguard Value ETF. Among the 10 biggest holdings are Bank of America, JP Morgan Chase and Citigroup. And in addition, you pick up a few oil companies and drug companies. Large, value-priced stocks as a group should generate less risk than bank stocks alone.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.